By Zongxin Qian (Assistant professor, School of Finance, Renmin University of China)

Illustration by Robert Wiggin

On March 5, 2016, China¡¯s Prime Minister Li Keqiang reported the objectives of the government in the next five years to the National People's Congress. The targets for gross domestic product and per capita income, to be achieved by 2020, are set at twice the level of those for 2010. The targeted economic growth rate is set at 6.5 percent. There is also a target for reform on the economic structure. The shares of advanced manufacturing, modern services, and strategic emerging industries in aggregate output should have significantly increased by 2020. The importance of technological progression for economic growth has been addressed by the Prime Minister. More specifically, there are also technology-related targets set by the government. Total spending on research and development for the entire economy has to reach 2.5 percent by 2020 and the contribution of technological progression towards economic growth has to reach 60 percent.

The target growth rate, 6.5 percent, is a much smaller number than the average number in the past 10 years, but is still relatively high compared to most major economies around the world. The government has a relatively high growth target for at least two reasons. First, a higher growth rate creates more consumable resources for the citizens, and hence can improve their living standards. This is particularly important for fighting poverty. Second, a reasonable growth rate is necessary for offering enough employment opportunities. The target growth rate is smaller than those of the past for at least two reasons. On the one hand, the world economic outlook is still not that good, which means that external demand-led growth, similar to that of the past, is no longer possible. On the other hand, economic structural reform comes at a cost. Those reforms are aimed at bringing more sustainable growth in the long-run but might slow down growth in the short run. For example, the government aims to increase the share of the service sector in terms of aggregate output. In the short run, the growth of the service sector might attract resources from the manufacturing sector and slow down its growth.

In the Prime Minister's report, the growth target for 2016 is set to be 6.5 - 7 percent. This target is believed to be enough for maintaining full employment and the Prime Minister explicitly mentioned that the target is set with consideration of the needs of economic reforms. Maintaining structural reform targets while aggregate growth is under threat is a brave decision. However, it is also necessary. The difficulties that China has faced since the onset of the global financial crisis are deeply rooted in our economic structure. In the past, rapid economic growth relied too much on exports and investment. This made the economy vulnerable to external shocks. China has a huge export sector, but many of the exporting firms are producing highly substitutable goods. Tougher international competition and rising labor costs suggest that the profit margin of those firms will decline. Innovation and technological progression can, however, enhance the international competitiveness of China's exporting sector. The transition from a traditional manufacturing sector to advanced manufacturing, modern services, and strategic emerging industries can also improve the country¡¯s competitive advantage.

Notably, in 2016, there are also targets for energy consumption and pollution control. More specifically, the energy consumption per unit of GDP has to drop by more than 3.4 percent, and emissions of major pollutants have to decline. In the past, the high growth number is partly supported by high energy consumption and pollution. Therefore, with the energy consumption and pollution control targets, 6.5 - 7 percent in 2016 is actually a better target than 6.5 - 7 percent in previous years.

As I have already mentioned, given the world economic outlook, 6.5 ¨C 7 percent is not a low target. The question is how to go about achieving it. The producer price index has been declining since late 2014. The decline in the growth rate of investment has also been accelerated since the end of 2014. Those declines cannot be fully explained by structural changes in the economy. I am afraid that those numbers suggest that the aggregate economic outlook is not so good. Therefore, while reforming the economic structure is still important, some aggregate measures have to be implemented in order to secure the achievement of the growth target for 2016. In the Prime Minister's report, the expected growth rate of M2 is 13 percent, which means that the government is going to maintain liquidity supply to the economy. But both economic theory and the experience of advanced economies in the Great Recession tell us that fiscal stimulus might be more important when short-run economic growth is under threat.

Obviously, the Chinese government has realized this. It plans to increase fiscal deficit by 2.18 trillion Chinese yuan while at the same time, cut the tax burden for firms. The total tax cut is estimated to be 500 billion Chinese yuan. These fiscal measures will inevitably increase the leverage of the central and local governments. As necessary measures to control sovereign risk, the government is going to speed up fiscal and tax reform in order to enhance both the capability and willingness of local governments to honor their debts. To prevent the government stimulus package from encouraging excessive risk-taking in the financial sector, the government will address financial regulation in 2016. Despite that, the Prime Minister's report still mentioned some reforms in the financial sector to enhance its efficiency, including the development of private banks, direct finance, and insurance for rare disaster risk. The details outlined above represent this year's major tasks for financial sector reform.

The demand-side policy also emphasizes the development of the domestic market. The development of service consumption, internet and information, smart home, express delivery, second-hand automobiles, parking, new-energy automobiles, and tourism are specifically mentioned in the Prime Minister's report. The government also addresses investment in infrastructure. Furthermore, urbanization is taken as the key driver for the development of the domestic market. In 2016, the main tasks are to accelerate the integration of rural migrants to the urban community, to reform the housing sector and to improve urban planning.

The government addresses the supply-side policies as drivers for economic growth. In particular, reforms in the government sector are planned so as to eliminate entry barriers and reduce the operating costs of the business sector. Tax benefits are going to be offered to innovating firms and the government will help create platforms for multilateral cooperation in research and development. The government also plans to give more autonomy to public universities and research institutes and provide incentives to researchers to innovate. Through mergers and acquisitions, debt restructuring and bankruptcy procedures, so-called "zombie firms," which are unproductive shall be eliminated.

In summary, the government's major task in 2016 is to achieve a growth rate necessary for full employment while continuing reforms on the economic structure. The "innovating" part of the policy mix, required in order to complete this task, is to address innovation in the private sector. Moreover, prudence so as to avoid excessive risk-taking is a non-negligible part of the policy package if the desired outcomes are to be achieved.

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